European broadband: What's the remedy?

With the EU's hope of creating widespread broadband access in Europe stalled, experts at McKinsey say that regulators must abandon their fixation on low prices.

4 March 20021:32 am AEDT

The European Union's hope of creating a digital society with widespread broadband access to the Internet has stalled. Saddled with debt, many incumbent telecommunications operators are cutting back on capital expenses.

Meanwhile, the upstarts that were supposed to break down the gates of Europe's entrenched monopolies are finding entry much tougher than planned. As a result, many new companies that were in the vanguard of the push for faster, more efficient access to the Internet are teetering on the verge of financial ruin. Added to this, upgrading cable TV systems has been more expensive and more complicated than expected.

All the players--attackers and former monopolists alike--are seeing sources of capital dry up, particularly for infrastructure improvements. Most have slowed down their broadband expansion plans, and some have decided to halt those plans altogether.

Regulators should be worried. Their vision of deregulated markets leading to widespread broadband penetration and broad consumer choice has been delayed.

About 4 million households in Europe have broadband, far short of forecasts of 36 million by 2005. A short-term focus on taking value out of the industry, mostly through lower overall price levels, has unwittingly dampened competition and slowed the introduction of broadband. It could also lead to perpetual local monopolies.

The challenges facing broadband are no longer technical or demand related. The real issue is economic. So far, deregulation has gone only half the distance--having shorn the incumbents of their total market control, regulators must now approach pricing regulation to facilitate deployment of competing infrastructure. Policy-makers and regulators must abandon their focus on continually pushing prices lower, at least in the short run. To help unlock broadband's full potential in Europe, they need to address three key issues.

The economics of local service
To stimulate competition in local service and to finance the expansion of broadband, which uses the same infrastructure, everyone--incumbents, attackers offering DSL (digital subscriber lines), and cable TV companies that offer cable modem and telephone services--must be able to earn adequate revenue from voice telephone connections. Current price levels for local services are not sufficient for this task.

In setting up price controls, regulators, after essentially calculating a theoretical cost base for incumbents, have allowed what they consider "normal" profits. But incumbents have universal penetration, and new companies lacking this scale face higher costs, which can destroy any potential profit.

Also, the controls were created before mobile telephones offered a viable market mechanism for preventing monopolistic profits for local service. In this regulatory environment, all players face difficulties in building a broadband business on top of a local-service business that is marginally profitable or posting losses.

Other options must also be explored, such as raising or stabilizing local interconnection fees--the price charged to fixed and mobile operators to connect to the local infrastructure. In addition, price caps should be eliminated or relaxed to allow more nimble price changes in response to market shifts and more creative service packages.

Cable television will play a smaller role in broadband access in Europe than in the United States. Only about half of European households are wired for cable, compared with about 90 percent in the United States, and the bulk of this infrastructure has yet to be upgraded to enable broadband delivery.

Yet in pockets such as Belgium and Holland--and increasingly in Germany and the United Kingdom--cable is a strong competitor to DSL, and penetration has been deeper.

Telecommunications and TV regulators must work together to allow cable to expand profitably. Where cable's TV business is regulated, providers should be allowed more flexibility to raise fees and to repackage programming offers. Onerous TV taxes should also be reconsidered; this will improve the cash flow needed to finance broadband investments.

In the United States, where revenue per subscriber is about $50 a month, cable companies can finance upgrades, but in Europe revenue per subscriber is as low as $10.

In addition, in countries like France and Spain, where the deployment or improvement of cable has been slow, regulators should find ways to mitigate construction costs, such as expediting municipal approvals and allowing cable companies to build according to demand rather than political expediency. Also, the consolidation of fragmented cable franchises--a major issue in Germany--should be allowed and satellite TV encouraged.

Opening the gates to attackers
Regulators must nurture more economically viable DSL-based attackers. To date, these efforts have focused on unbundling the system, compelling operators that own the infrastructure to offer access to new players at reasonable prices. But using this unbundled infrastructure has been more expensive and complicated than originally expected. At current customer price levels, the effort is justified only in areas with high customer density. In addition, incumbents have been slow in opening their systems.

To make unbundling work, regulators must ensure that incumbents don't suffocate attackers between wholesale and retail price levels. Regulators must look beyond simple access fees to other costs imposed by incumbents, such as charges for space in equipment buildings, leased lines, and other necessities. Stronger penalties for operators that clearly obfuscate the process are also needed.

But unbundling is not enough. Regulators should encourage the deployment of alternative access: two-way satellite, wireless, cable, and even fiber networks.

While the business cases for these technologies must be solid, governments can help by making spectrum available, expediting licenses, and providing direct assistance to deliver coverage to underserved areas.

However, where competition is weak or nonexistent, regulators may have to couple incentives for incumbents with specific broadband coverage targets. Direct performance requirements, such as penetration targets, may be the only effective tool to accelerate broadband deployment in some areas.

Of course, enlightened regulation alone will not be enough to cover Europe with broadband. Companies must also fix some major operational problems, reduce up-front capital outlays, and examine and refine their business models to ensure that broadband is a viable system for all participants, from content providers to consumers and equipment vendors.

Lawmakers and regulators must steer toward an integrated set of policies that stimulate competition for broadband and local services and allow the financing of these improvements.

To realize their aspiration of a broadband Europe, they must shift their focus from extracting value through licensing fees, privatization, and overregulated consumer prices to supporting carefully--but not coddling--an industry that faces a complicated and expensive infrastructure challenge.